Vitamin AAA Deficiency

No sooner had the US government released its budget for fiscal year 2011 did Moody’s Investment Services weigh in with its stern response.

“Unless further measures are taken to reduce the budget deficit further or the economy rebounds more vigorously than expected,” the rating agency reported in an issuer note, “the federal financial picture as presented in the projections for the next decade will at some point put pressure on [America’s] triple A government bond rating.”

It was a wonky way of saying the US had taken a step closer to national bankruptcy, a warning that could just as easily have been issued to Greece, Portugal, Spain or Italy. With the bailouts and stimulus packages ladled out in response to the 2008 credit collapse straining balance sheets worldwide, investors await anxiously for the first major default. The dubious association of America as just one among a host of countries on the brink of bankruptcy was little noticed or remarked upon in Washington DC, a fact that should be of great concern to serious-minded individuals everywhere.

A few years ago, as the US was running budget deficits worth a half-trillion dollars annually and the federal government was swelling in size–on the eve of the 2008 crash, real discretionary spending during George W. Bush’s two terms as president had risen by 44 percent–the suggestion that Washington might default on its sovereign debt was roundly dismissed. So long as the US dollar served as the world’s reserve currency, it was argued, the Treasury could endure any crisis simply by printing money.

Just over a year into the Obama administration, economists and investors are no longer taking American solvency for granted. Officials in China, America’s top banker and increasingly seen as less a partner than a potential adversary, have suggested that the days of the dollar as the world’s fiat currency may be numbered. Late last year, French President Nicolas Sarkozy called for a new global monetary system at the top of which the dollar was conspicuously absent. There are reports that some major sovereign wealth funds are diversifying their foreign exchange reserves away from the US currency.

Considered separately, such statements and gossip amount to little. Taken together, however, they reflect growing concern that the once-mighty dollar and the shaky US economy behind it are no longer the sure things they once were.

“Investors are getting nervous about this,” says Morris Goldstein, a senior fellow at the Peterson Institute for International Economics. “The question is do you believe Obama’s budget can cut the deficit? If not, you run into problems because the perception of sustained high deficits means high long-term interest rates, particularly if the dollar goes into decline. So it’s important to convince people you’re serious about this.”

Fortunately for the global economy, China has rebounded from the immediate impact of the credit crunch and has all but relieved the US as the engine of global growth. (With a gross domestic product of $4.3 trillion, China will soon replace Japan as the world’s second largest economy but is still less than a third the size of America’s GDP.)  That is particularly good news for developing regions such as the Middle East, where China has become a major source of investment and a key trading partner.

However impressive China’s rise, it is not inexorable. Sooner or later, the country’s business cycle will turn south. The country faces the spectre of potentially ruinous inflation as property and equity prices enter bubble territory. Sooner or later, Beijing will have to allow its currency to appreciate against the dollar in a bid to pre-empt inflation, a delicate transition that could destabilize the economy if not managed well.

The short-term focus, however, remains on the US The concern is less about the size of America’s debt, which is indeed vast, but Washington’s dystopic polity. In an unusual move, the Obama administration included in its budget projection a ten-year outlook that forecast $1 trillion annual deficits averaged out for the next decade. In response, members of a gridlocked Congress spent much of the following week trying to salvage pet projects slated for the budget knife, including costly weapons systems the Pentagon itself has identified as unnecessary. In short, Washington has done little to assure investors it is at all serious about deficit reduction.

Optimists cite America’s redemptive performance in the 1990s, when a robust economy – powered by a high-tech boom that would ultimately go bust – grew its way out of a budget deficit and entered the new millennium with a tidy surplus. The magnitude of indebtedness the US faces today, however, is the greatest since 1950. For the US to reclaim some measure of fiscal stability, it will require the kind of political leadership and courage that Washington abjectly lacks.

According to the Obama budget, the ratio of debt to the gross domestic product will have risen to 77 percent by 2020. Beyond that, however, is where the real debt-trap lies. Members of America’s baby-boom generation–those born from 1945 to 1960 or so–are already beginning to retire. Soon, the nation’s entitlement programs will lurch from surplus to shortfall as a growing number of retirees draw more from their accounts than working-age individuals are paying in. Economist’s estimate the long-term funding gap just for Medicare, the national health-care plan for the elderly, at $36 trillion. Medicare, together with Social Security, the national retirement scheme, and Medicaid, a subsidized medical program for the poor, accounts for two-thirds of the budget.

Absent fundamental reform, some studies show, these mandatory expenditures will have all but crowded out America’s non-defense budget items by 2020. A decade beyond that, economists warn, the value of public debt is expected to reach 100 percent of GDP. 

Reform, of course, requires negotiation and compromise. Having watched lawmakers bludgeon themselves with no result over Obama’s health care bill, economists are not hopeful that Congress can make the hard choices needed to navigate the economy from the shoals of insolvency. At the very least, many fear a slide back into recession, followed by a generation of sluggish growth.

The last several decades have been filled with unfulfilled prophesies about America’s decline as a superpower, dating back to the 1950s when right-wing alarmism distracted the nation from its clear superiority over Soviet Russia. In the 1980s, it was Japan that was supposed to have replaced the US as the world’s economic leader. Soon, it will be China’s turn, so say the experts.

The US has some ways to go before it becomes just one global power among many. The clout that comes with a $14 trillion economy, after all, is not easily dismissed. Washington has clearly shown, however, that even the world’s most powerful nation cannot indefinitely draw down its treasury without depleting its authority along with it.

Stephen Glain